Banks and credit unions are worried that the instantaneous nature of FedNow payments doesn’t leave any time to stop fraud in its tracks, unlike wire transfers. iStock illustration

The Federal Reserve launched its instant payments system, FedNow, on July 20, but many local banks are taking a wait-and-see approach in the face of fraud concerns.  

FedNow allows banks, credit unions and other financial institutions to offer real-time payments and money transfers to their customers 24 hours a day, seven days a week. Proponents say this means convenience and assurance for ordinary consumers that they can avoid late fees when paying bills at the last minute and businesses can pay suppliers or be paid instantaneously.  

But despite this promise, only three Massachusetts banks had signed on as early adopters by launch day: Hudson-based Avidia Bank, Holyoke-based PeoplesBank and Salem Five. In total, 36 banks and credit unions across the country are early adopters, plus 16 service providers to help banks with payment processing and connecting their existing systems to the FedNow network. 

Lenders vs. Real-time Fraud 

While real-time payments systems are needed to meet demands from today’s banking customers, there are still security risks and even instances of wire fraud in different sectors such as the real estate sector. Compared to wire transfers, which can be recalled within 24 hours of a transaction, a real-time payment through FedNow or TCH’s RTP system cannot be undone once a transfer is completed. 

American Bankers Association incoming board chair Julieann Thurlow said banks and credit unions need to build layers of protection and safeguards around these and other risks – whether with software, behavioral transaction checks or other methods – to prevent fraudulent transactions especially when rules on where the responsibility lies during a fraud incident aren’t yet clear. 

In a scenario where a depositor sends money from their account in a transaction that was properly authenticated, but their authentication codes were stolen or given to other people, responsibility for the fraud – and thus who has to pay – is still unsettled said Thurlow, who is also president and CEO of Reading Cooperative Bank. 

“What are the fraud mechanisms that you can actually put in front so that you can protect consumers and make sure that people can’t hack into their account and move money instantly out somewhere? I don’t think the rules really have been finalized yet as far as the CFPB  goes on where is the responsibility and who owns the risk… Fraud is the big challenge because once the money is sent, it is gone,” she said. 

Thurlow pointed out that the ability to send and receive large sums of money instantly could also “destabilizing” for banks. Real-time payments will “open the floodgates,” during a bank failure by allowing deposits to flee even faster than the unprecedented, 36-hour bank run that took down Silicon Valley Bank, she said, noting that a bank could even fail overnight as they are required under FedNow rules to allow exit transactions of up to $500,000 in real time. 

“The other thing that hasn’t even been thought about at the bank level is, what about weekends? This is real–time payments, so that means Saturday and Sunday are included. Most fraudsters, if they’re going to start hacking accounts or they’re trying to spoof banks, will carry out their fraudulent activities starting on Friday night until Monday morning so that it’s not picked up by the banks until then,” Thurlow said. 

But the fraud problem isn’t unique to FedNow, said Rob Ames, head of digital delivery at Salem Five. 

“There is risk across all payments infrastructure channels and products. How to manage instant payments risk is a key aspect of the FedNow pilot program. As a pilot participant and early adopter, our approach has been to test, learn, adopt and scale, ensuring that the necessary controls and risk models in place,” he added. 

Lenders Take Precautions 

To shield its customers, Ames said that Salem Five has come up with proprietary programs, controls and protocols which are built within the real-time payments products and infrastructure that they have established. New products built around the FedNow infrastructure will likely include fraud controls, too, he said. 

Salem Five has also started its participation as a “receive-only” participation in the FedNow, but is currently working towards being able to use FedNow for customers’ bill payments.  

“We’ll also look at some fintechs and others to see what new or innovative products come to the market and start to utilize these rails, because that will happen,” Ames said. 

Chelsea-based Metro Credit Union hass yet to apply to join the FedNow service, preferring to observe its early-adopting peers first and allow their experience to improve Metro’s preparedness in adopting the new system. 

“We know that there’s some institutions that are currently rolling it out now, and there’s some beta institutions that are just starting to roll it out. We wanted to see how that was going to go for some of the betas and time it as well to some of our other infrastructure projects. But I can safely say that Metro will definitely be having those products in 2024,” Metro President and CEO Robert Cashman said. 

Metro has been working to establish its digital infrastructures to get ready for FedNow and instant transfers, such as artificial intelligence and voice authentication. 

“We’ve started looking at AI. We’ve partnered with some companies to help us on the front end when our members call in, how their calls can be routed, how the calls can be answered quickly and more efficiently. We’re also looking at voice authentication that will help with nobody speeding up the process, but we think is a great fraud deterrent,” said Cashman.  

Innovation on the Way 

Following FedNow’s launch, Reading Cooperative Bank’s Thurlow said clear rules and guidelines still have to be fleshed out to mitigate risks real-time payments systems pose for banks. She pointed out that banks and credit unions will have to determine their own prevention and protection systems depending on their own risk appetite. 

“There are elements that need to be thought out fully for what are the risks in a truly real time framework, [and what that] means for the bank. Once we have those risks, then we can figure out how to mitigate those, whether it be through software or AI that is coming in the landscape, which is just the right time because we are learning that behavioral transactions can actually serve as really good fraud mitigants,” Thurlow said. 

Still, FedNow is generating excitement for its potential to unlock new products and services for local banks. Since the service just launched, Salem Five’s Ames said, its full potential will materialize over the next few months or years as banks and credit unions explore its possibilities. 

“Over time, we are going to see product innovation and product extensions that are able to leverage these new and faster real-time payment rails. We’re going to really see a change in the way consumers and businesses interact with their payments. Customers won’t know necessarily that it’s running across FedNow rail or [The Clearing House’s] RTP rail. They will just know that their payments are moving in real time, both on the receive side and the originate or send side,” Ames said.